United States: Blockchain For Business

Introduction

Interest in blockchain has grown dramatically, with a rapid
increase in investment and engagement. Over the course of 2017,
numerous companies in financial, automotive, healthcare, insurance,
real estate, retail, and other sectors have developed sophisticated
proof-of-concepts and some are on the path to significant
production deployments.

Despite the increasing attention to blockchain, the topic
remains novel for many business lawyers. As companies begin to
explore blockchain, however, it is increasingly important for
lawyers to be able to spot the right issues and ask the right
questions. In light of this, our goal is to introduce blockchain in
simple terms, provide example use cases, and highlight some of the
most pressing legal issues.

What Is Blockchain?

Blockchain technology was first implemented in 2009 as the
underlying platform designed to solve the
"double-spending" problem for Bitcoin (that is, how to
transfer digital value without relying on a trusted third party).
However, the attributes that make blockchain technology essential
for Bitcoin can be used to solve a variety of other problems. A
blockchain is:

A digital ledger representing a history of transactions,

That is distributed on computers (also called "nodes")
operated by different participants,

That allows participants to introduce records with cryptographic
protection that are validated and immutable.

The records in a blockchain are immutable because information in
the digital ledger is stored in blocks of data that are represented
by a unique cryptographic identifier (or "hash"). Each
subsequent block of data includes the hash of the prior block to
create a chain that links all the way back to the first block of
data (hence "blockchain"). If data in any block in the
chain is later illicitly altered in any node's version of the
ledger, the hash for that and every subsequent block must change,
making such altered ledger readily identifiable as an illicit
version. That illicit version is then rejected by consensus among
the nodes.

A feature of some blockchains is the capability to create
"smart contracts." For example, the Ethereum and
Hyperledger blockchain platforms permit the recording of software
programs within a block on the blockchain itself. This software
automatically performs certain actions on the blockchain when a
prescribed condition is met. As an example, a supplier who today
ships goods to a customer, sends an invoice, and waits 30, 45, or
90 days for payment would prefer to have the order in a "smart
contract" that pays automatically when the customer
acknowledges receipt of goods on the blockchain. Alternatively, the
software can trigger payment based on data from an outside source,
referred to as an "oracle." For example,
"parametric" travel insurance could pay automatically if
an airline cancels a flight, with the airline's flight records
being the "oracle."

Where Can Blockchain Be Useful?

Because of the shared and immutable nature of information stored
on a blockchain, blockchains can be expected to drive the most
value for businesses by solving problems in maintaining consistency
of records between multiple entities, maintaining auditable
information trails, efficiently settling and tracking exchanges of
value, and authenticating user identity.

At this point, commercial blockchain is largely in the pilot or
proof-of-concept stage across a wide range of use cases. Payments
and supply chain are two of the most promising use cases.

Payments

With the rise in global business and trade, financial
institutions are focused on optimizing cross-border payment
inefficiencies. Current protocols require correspondent banking
relationships and include intermediaries, resulting in high fees
and inordinate delays. Using a blockchain to handle such payments
can permit a bilateral, immutable transfer of value while reducing
the fees charged and delays caused by existing processes. A number
of financial institutions have announced pilots testing such
blockchain solutions. In addition, the R3 and Hyperledger consortia
are each working towards creating blockchain standards for payment
and other financial sector use cases.

Supply Chain

Current supply chain processes rely
on nonstandardized paper and digital records held among various
parties, often resulting in minimal or delayed ability to pinpoint
where problems arise in the supply chain.

Diamond companies are testing an
industrywide blockchain that allows suppliers to record each
movement of a diamond, tracking its conflict status.

Retail and e-commerce companies are
developing in-house blockchains to similarly track authenticity of
goods they sell and combat counterfeiting.

A number of food giants have
partnered with IBM to use blockchain to track foodstuffs from farm
to store.

Possible Legal Issues

We set out possible legal issues below, including (i) issues
that can be partially or wholly addressed by the way that the
blockchain is designed, (ii) issues that can be partially or wholly
addressed by a separate off-chain agreement among participants, and
(iii) other issues to be weighed in determining whether to
implement a blockchain solution.

Legal Issues to Address in On-Chain Programming

Confidentiality Requirements. In a
"permissionless" blockchain, data can be viewed by anyone
on the Internet. For some applications, such as an online database
to prove auto insurance coverage, that may be preferred. If there
are obligations of confidentiality, however, the blockchain may be
"permissioned" (so that participation is limited by
either having an administrator determine ability to participate or
having objective requirements that must be met to participate) and
can limit viewing of the full record only to specific
participants.

Accountability Requirements. Many public
blockchains allow people to become participants and engage in
transactions by revealing only their public key (as is the case
with Bitcoin). However, if the use case requires that a known
person be accountable for what is placed on the blockchain, the
blockchain or its governing body can require proof of identify
before a participant is provided access. The blockchain might then
require that the participant's identity be visible to
transactional counterparties, to trusted nodes, or to all
participants, as applicable.

Data Privacy. Blockchains have key challenges
in relation to data privacy laws. For example, a node in a non-EU
country recording a block in the chain that includes personal data
of an EU resident may be considered a cross-border transfer of
personal data. As another example, recording personal data in an
"immutable" ledger may violate a right for data subjects
to require that their data be removed (the "right to be
forgotten"). The blockchain could be designed to encrypt the
personal data with an encryption key that can be forgotten or to
store the personal data off-chain in a database permitting deletion
with only links to such data stored on-chain.

Legal Issues to Address in Off-Chain Agreements

Design, Build, and Run. A blockchain must be
designed and financed by a team with deep understanding of the use
and may be implemented using software developers on a licensed or
subscription platform—a large effort involving numerous
contracts.

Amendments and Modifications. A blockchain may
need to adapt to survive and maintain its usefulness. For
permissionless blockchains, success may depend on whether the
participants can make the right modifications through consensus.
For permissioned blockchains, however, the founders can formalize
the governance process off-chain via a separate, manually signed,
natural-language agreement. In that off-chain agreement, the
consortium or founding participants can set rules and principles
for how to come to agreement (or designate trust in an
administrator) to modify the blockchain's programming.

Allocation of Liability. A participant may be
damaged, for example, by a vulnerability in the underlying
technology, an issue with one of the nodes, a participant's
failure to protect their private keys, or an issue involving the
way an external system integrates or operates with the blockchain.
The law is at best unclear on whether the damaged participant would
have a claim against other participants, the programmers, the
technology providers or others. Blockchain consortia can address
this problem by requiring participants to enter into a legally
binding off-chain agreement that allocates responsibility and
liability.

Jurisdiction, Governing Law, and Dispute
Resolution. Blockchains, by definition, involve numerous
nodes keeping simultaneous copies of the digital ledger in their
own hosting locations, which may be in separate countries. Each
node may participate in the process of creating consensus and
recording information to the blockchain. Thus, it is not clear
which country(ies) have jurisdiction or what law(s) govern. Again,
a consortium or founding group can stipulate the governing law,
jurisdiction and the agreed dispute resolution process (such as
arbitration) for all participants in the off-chain agreement.

Smart Contracts. A "smart contract"
is made up entirely of code. While one might argue that the digital
interaction between "smart contract" software and a
participant (or a participant's software) constitutes offer and
acceptance and a legally binding contract, this would be a legally
novel interpretation of traditional contract formalities. Until
regulators decide how to approach this technological advancement
(as they have had to do in the case of e-signatures, electronic
contracts, clickwrap agreements, and other deviations from
traditional contract formalities), a "smart contract"
could be supported by appropriate off-chain natural language
contracts. At that point, it will be critical to verify that the
"smart contract" code actually carries forward the legal
effect of the traditional contract.

Oracles. There is a risk that the oracle is
incorrect, inaccurate, or ambiguous. In such scenarios, companies
may document how such inaccuracies are to be handled and how risk
and liability is allocated in such events in the offchain
agreement.

Other Issues

Distributed Autonomous Organizations. Some view
a blockchain operating independently of a consortium as a
distributed autonomous organization (DAO) consisting of code
running on distributed servers. A key question in participating in
a DAO is whether participants have any recourse against anyone for
the actions of the DAO.

Functionality Limitations. Blockchain is an
emerging technology with potential functionality limitations. For
example, currently many blockchains have limited capability to
perform advanced searches or otherwise retrieve information stored
on-chain. Companies should weigh these limitations against the
advantages gained, at least until the limitations are
addressed.

Integration. Commercial blockchain will require
the communication of data to and from each blockchain. Currently
interoperability between blockchains is limited and few interfaces
have been built to ERP systems and systems of record. Solving this
problem will require participants to agree on technical standards
and software providers to build interfaces.

Antitrust. Consortia created for the purposes
of arriving at common technical standards and frameworks for
industry blockchains might be viewed as improper collusion between
the participants or as resulting in anti-competitive effects. For
example, in a permissioned network, industry competitors who are
not included may be disadvantaged. Antitrust and competition law
advice are thus essential.

1 Rohith George is a partner in the Technology Transactions
practice in Mayer Brown's Palo Alto office. Brad Peterson is a
partner in Mayer Brown's Chicago office. He leads the
Technology Transactions practice. Oliver Yaros is a partner in the
Intellectual Property & IT Group of the London office, having
joined Mayer Brown as a trainee in 2004 and admitted to practice in
2006. David Beam is a partner in Mayer Brown's Washington, DC
office. He is a member of the firm's Financial Services
Regulatory & Enforcement group. Julian Dibbell is an associate
in Mayer Brown's Chicago office and a member of the Technology
Transactions practice. Riley Moore is an associate in Mayer
Brown's Technology Transactions and Corporate & Securities
practice.

Mayer Brown is a global legal services provider
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This
Mayer Brown article provides information and comments on legal
issues and developments of interest. The foregoing is not a
comprehensive treatment of the subject matter covered and is not
intended to provide legal advice. Readers should seek specific
legal advice before taking any action with respect to the matters
discussed herein.

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